Antonella Franzen - Johnson Controls International Plc Alex A. Molinaroli - Johnson Controls International Plc George R. Oliver - Johnson Controls International Plc Brian J. Stief - Johnson Controls International Plc.

Gautam Khanna - Cowen & Co. LLC Nigel Coe - Morgan Stanley & Co. LLC Jeffrey T. Sprague - Vertical Research Partners LLC Deane Dray - RBC Capital Markets LLC Julian Mitchell - Credit Suisse Securities Charles Stephen Tusa - JPMorgan Securities LLC.

Welcome to Johnson Controls' Second Quarter 2017 Earnings Call. Your lines have been placed on listen-only until the question-and-answer session. This conference is being recorded. If you have any objections, please disconnect at this time. I will now turn the call over to Antonella Franzen, Vice President of Investor Relations, you may begin..

Good morning and thank you for joining our conference call to discuss Johnson Controls' second quarter 2017 results. The press release and all related tables issued earlier this morning, as well as the conference call slide presentation, can be found on the Investor Relations portion of our website at johnsoncontrols.com.

With me today are Johnson Controls' Chairman and Chief Executive Officer, Alex Molinaroli; President and Chief Operating Officer, George Oliver; and our Executive Vice President and Chief Financial Officer, Brian Stief.

Before we begin, I would like to remind you that during the course of today's call, we will be providing certain forward-looking information. We ask that you view today's press release and read through the forward-looking cautionary informational statements that we've included there.

In addition, we will use certain non-GAAP measures in our discussions, and we ask that you read through the sections of our press release that address the use of these items.

In discussing our results during the call, references to adjusted EBITA and adjusted EBIT margins, exclude transaction, integration, and separation costs, as well as other special items. These metrics are non-GAAP measures and are reconciled in the schedules attached to our press release.

All comparisons to the prior year are on a combined basis, which excludes the results of Adient, and includes the results of Tyco net of conforming accounting adjustments and recurring purchase accounting. Now let me quickly recap this quarter's results.

Sales of $7.2 billion in the quarter, increased 3% year-over-year on a reported basis, excluding the net impact of FX, M&A and lead pass-through pricing, sales grew 2% organically.

GAAP loss per share from continuing operations attributable to Johnson Controls' ordinary shareholders was $0.16 and included net charges of $0.66 related to special items.

These special items were primarily composed of a non-cash tax charge related to the announced divestiture of the Scott Safety business, transaction, integration and separation costs as well as restructuring and impairment charges.

Adjusting for these special items, non-GAAP adjusted diluted earnings per share from continuing operations was $0.50 per share compared to $0.45 in the prior year quarter. Now, let me turn the call over to Alex..

Thanks, Antonella. Good morning, everyone. So, if we start on slide 5, I'd like to talk about the overview of the results and some of the commitments we've made over the past few months, both at our Annual Meeting, our Investing Meeting and then also at our Analyst Call.

So, we had strong quarter earnings at 11% year-over-year growth and is at the top end range that we provided you at $0.48 to $0.50. And a lot of that came from our continued focus on our productivity and the integration efforts.

If you go back and look at the commitments that we made as an organization, I think that we couldn't be more proud of our employees and it both came from productivity driven through our Johnson Controls operating systems initiatives along with the merger synergies.

And in fact, we've seen around a $70 million benefit for the quarter, which is accelerating, so we're very pleased with what we're seeing and I just want to thank our employees.

It would be very easy for our employees with all that's going on to not stay focused on the task and we've been able to generate the synergies and the cost savings which will bode well for the future. It leads me to the organic growth, particularly within buildings.

We're starting to see the acceleration of our organic growth, particularly in our field businesses and once again that's where we're doing most of our integration efforts, so that's a strong signal to us that we're going to continue to see growth throughout the rest of the year and gives us confidence.

I'd really like to also point out and George will go through this in a little more detail, we had really strong strength in our HVAC businesses, particularly our light commercial and residential businesses. We outpaced the market and most of that has to do with launches of new products and the investments that we've seen over the past few years.

And we're seeing some stabilization within the legacy Tyco fire protection products businesses and that bodes well for the future also. The other thing that happened within the quarter is some of our strategic portfolio actions. Specifically, we closed the sale of ADT South Africa and we announced the divestiture of Scott Safety to 3M.

Both of these are very important as it relates to those businesses within the legacy Tyco organization being able to sell those assets is important as it relates to the TSarl debt which as you recall was a $4 billion debt that was put in place to facilitate the transaction between Johnson Controls and Tyco, and accelerating that repayment of debt is going to be good for us moving forward.

Related to that, is the share repurchase program of $500 million which is an increase from the previously announced $200 million to $250 million share repurchase program, that's already in place. So, that takes us up to $750 million for the fiscal year. So, the Scott Safety transaction will not be dilutive.

If you go to page 6, I'll go a high overview of the numbers before I turn it over to George. If you look at our net sales of 3% reported and organic of 2%, buildings was up 3%. I talked earlier about driven mostly by our field organization and power is off 1%.

And that was mostly a seasonal view, particularly because of some of the weather and restocking along with strong orders that we received a year ago, in China, when we first opened our new plant.

And from a results standpoint, if you look at the impact of lead, it's pretty important because if you pull out lead, which was up significantly for the quarter, we had a 7% increase excluding both foreign exchange and lead, and there was a significant impact to our bottom line, I mean, to our top line and also impacted our margin.

So if you adjust for that, we had a 7% increase in earnings driven by real strong performance in our Power Solutions business. And that leads us to the 60 basis points improvements in overall margins. The integration of our Buildings business as it accelerates and we get more and more confidence, we're going to see the bottom line continue to improve.

And now that we're starting to see the organic growth within our Buildings business, gives us an awful lot of confidence to tighten our guidance for the year, which Brian will talk about, which is the 13% to 16% range, later in the presentation.

So with that, I'm going to turn it over to George, he'll talk about the merger activities and also some more specifics around the business performance..

Thanks, Alex, and good morning, everyone. Before I get into a detailed review of the businesses, let me start with a quick integration update on slide 7.

Over the last few months, the Buildings organization has gone through an impressive amount of change, and we've made a considerable amount of progress towards aligning the new leadership structure in the most optimal way possible with a focus on accountability for growth.

We now have the management teams of our operational structure substantially in place and we'll now focus on building out the team structure over the next several months. Another area we've discussed with you is the need to substantially pay down the merger-related TSarl debt.

As Alex referred to earlier with the announced divestiture of Scott Safety and sale of ADT South Africa, we will be able to make a considerable reduction to the $4 billion of debt. This will enable us to move more quickly on some of the heavier lifting restructuring and synergy actions.

I wanted to take a minute to thank the team and the thousands of employees of both Scott Safety and ADT South Africa. I have had the pleasure of being involved with both of these businesses for over a decade, including my tenure as President of the Tyco Global product segment.

It's never easy to part with such great leaders and colleagues, but I am confident they are in good hands and that both businesses will continue to be successful in the future. Before I get into the progress we've made on the cost side, I thought I'd highlight a couple of key cross-selling wins in the second quarter.

We had a major win in the New England region to supply an array of building solutions in a new distribution hub being built by one of our large airfreight delivery customers. In this situation, our legacy SimplexGrinnell sales team leveraged their strong relationships in the region to provide a lead to a legacy Johnson Controls team.

Working together, the two teams were able to secure contracts for the fire alarm system as well as the HVAC and building control system.

In the institutional space, a legacy Johnson Controls Account team in coordination with the sales teams across SimplexGrinnell and Tyco Integrated Security submitted a joint bid for a fully integrated solution multi-phase expansion project at a major university in Texas.

As a result, we were awarded the contract for the first phase providing our Metasys building automation system, York air handling units, Simplex fire alarm system, as well as access control and video surveillance. Not only is this phase a great win, we're well positioned for the next phases of the project.

Both wins are great examples of how our teams are coming together to collaborate and provide integrated solutions that solve more complex customer problems. Turning now, to the cost synergy side. We continue to run ahead of plan in Q2, delivering roughly $70 million or above $0.06 in year-over-year savings.

This is roughly $20 million in incremental savings over last quarter and is slightly ahead of our internal targets. Given the progress we've made year-to-date we now expect to achieve synergy and productivity savings at the high end of the $250 million to $300 million range I provided to you in December.

With roughly $0.11 achieved through the first half, we now expect $0.07 in the third quarter and $0.09 in the fourth quarter totaling around $0.27 in savings for the full year. As I mentioned last quarter, the integration of two large organizations requires a lot of heavy lifting, commitment and leadership.

Not all decisions are easy, but we have a strong team, leading the process, ensuring we execute on decisions made and we move forward to the next step. Both the integration team and the businesses continue to be guided around four main objectives; grow, integrate, change and operate.

We're making great progress and I couldn't be more proud of how the teams have come together and what they have accomplished over these past eight months as a combined company. I look forward to keeping you updated on our continued success. Let's turn now to a review of the businesses starting with Building Technologies and Solutions on slide 8.

On a reported basis, Building sales grew 1% over the prior year to $5.5 billion in the quarter, as 3% organic growth was partially offset by the impact of FX and net M&A activity. The 3% organic growth was led by solid growth in our field businesses.

When you look at the Field side of the business, which represents about 65% to 70% of total Building sales, organic growth was up 4%, with underlying growth across most regions, led by strong growth of over 3% in North America.

When we look at the pieces within our Field business, we saw another strong quarter of organic growth in our applied HVAC business, which continued to grow in the mid-single digit range. Fire and Security, the legacy Tyco Installation and Service businesses grew in the low single-digit range led by mid-single digit growth in North America.

Some of the areas within our Field businesses have put pressure on our organic growth rate in the first quarter, stabilized in the second quarter including both performance contracting and industrial refrigeration. Looking now at our Products business, which represents remaining 30% to 35% of Buildings.

Sales declined just under 1% organically year-over-year, a sequential improvement from the 3% decline we saw last quarter.

We continue to see very strong growth in our residential and light commercial HVAC business, which grew at a high-teens rate organically, benefiting by a significant amount of new product launches, something we expect will continue into 2018. The strength in U.S.

residential and light commercial HVAC was more than offset by a mid-single digit decline in our Hitachi business, simply related to the timing of shipments, which we will see come through in the third quarter. Additionally, our Fire and Security product businesses are stabilizing.

The mid-single digit, year-over-year decline we saw in the first quarter has moderated to a 1% organic decline in the second quarter. On a sequential basis, Fire and Security product sales are growing.

We've seen encouraging signs that the short cycle industrial markets have bottomed and we would anticipate some inflection across the businesses in the second half. Buildings' EBITA declined 1% year-over-year to $628 million.

The segment margin decreased 30 basis points year-over-year to 11.3% as strong synergy and productivity savings were more than offset by planned incremental product and channel investments as well as mix during the quarter. Turning to orders and backlog on slide 9.

Total Buildings orders increased 2% year-over-year organically, driven by a 3% increase in Field orders, partially offset by a 1% decline in our quick-turn product orders, which as I mentioned earlier was already felt within our product sales growth in the quarter, given the book and ship nature of that business.

In terms of order activity we saw continued momentum in the U.S. market with stable growth in non-residential construction verticals year-over-year. We had a strong quarter of order activity with solid growth in our commercial and institutional verticals.

As we have discussed before order growth in our Field business is lumpy, and can be impacted by the timing of large projects. The legacy Tyco business included a very large order in the prior year, which impacted the year-over-year comparison in Tyco orders by 3 percentage points.

Backlog of $8.3 billion increased 6% year-over-year, excluding the impact of foreign exchange and M&A. In summary, we continue to make significant strides in improving the fundamentals of the business. We are streamlining the organization, investing in our product and service innovation and driving commercial excellence.

As a result of these initiatives, coupled with our order pipeline and backlog, we are well-positioned for increased growth in the second half of this fiscal year as well as strong margin expansion. Turning to Power Solutions on slide 10.

Sales increased 7% year-over-year on a reported basis to $1.7 billion driven by the impact of lead pass-through, which benefited powers top line by roughly 8 percentage points. Organic sales were down 1%, driven by warmer weather in both North America and China, which negatively impacted aftermarket demand.

In addition, we had a tough prior year comparison in China associated with the timing of the initial volume build in our Chongqing plant. Overall, total global unit shipments decreased 3% year-over-year driven by aftermarket shipments, which declined 3%.

Global start-stop shipments continued to expand with a 36% increase year-over-year, including another quarter of significant growth in China and the Americas. Power Solutions segment EBITA of $303 million, increased 7% on a reported basis or 12% excluding foreign currency.

Power's margin expanded 10 basis points year-over-year on a reported basis including a 220 basis point headwind from the impact of higher lead costs.

Underlying margins excluding the impact of lead, increased 230 basis points year-over-year, driven by productivity benefits as well as favorable product mix, primarily related to higher Start-Stop battery shipments.

Now let me turn the call over to Brian to walk through corporate and the consolidated financial details of the quarter as well as our outlook for third quarter and remainder of the year..

Thanks, George and good morning, everyone. Turning to slide 11.

As you know, beginning in the first quarter, we're now reporting corporate as a standalone segment and for the second quarter corporate expense was $2 million lower than last year and as expected I think, we talked during the first quarter call that there was going to be a sequentially higher Q2 corporate costs than Q1 and that really related primarily to some indirect tax items and some IT related costs.

Having said that, for the full year we now expect corporate expenses will likely fall at the lower end of our $480 million to $500 million range that we provided at the Analyst Day. Moving on to slide 12.

As you saw in our release and as Antonella mentioned our Q2 results do include a number of large items again this quarter that we're treating as special non-GAAP adjustments. And, I'd just like to touch on those for a second. The first item relates to our ongoing transaction and separation costs that was roughly $138 million.

We had some restructuring and impairment charges in the quarter of $99 million about two-thirds of that related to severance, and we had some mark-to-market pension and some non-recurring purchase accounting adjustments that aggregated $35 million.

And then, the large item in the quarter was about a $457 million, non-cash tax charge related to the announced divestiture of Scott Safety.

And I would just give you a reminder here that, that is a non-cash book charge and the actual cash tax charge when that transaction closes, later in 2017, we still believe that will be in the range of $50 million. I'll exclude those items as I go through my comments, but those items aggregated $0.66 a share for the quarter.

So, turning to the highlights on slide 12, overall, second quarter sales were up 3% to $7.2 billion. And if you exclude the impact of FX lead and M&A, organic sales were up 2% versus last year and as George mentioned backlog year-over-year is up 6%, which bodes well for some momentum going into the second half here.

If you look at gross margin of 31%, it was down 40 basis points for the year that was primarily, or for the quarter, that was primarily driven by higher lead prices and some unfavorable Buildings mix that George referenced, and that was offset by leverage on higher volumes, as well as some JCOS productivity savings we saw come through in Q2.

SG&A levels were comparable to the prior year, up about 1%. This product, channel, and sales force investments were substantially offset by cost synergies. Equity income of $53 million, was 33% higher than a year ago and that was primarily due to strong performance in our Hitachi and Power Solutions nonconsolidated JVs.

For the quarter EBIT was up 5% with the overall EBIT margins up to 9.8% which is 20 basis points positive versus 2016, which is in line with our expectations and if you will exclude foreign exchange and lead, these margins were up 60 basis points year-over-year.

Turing to slide 13, net financing charges of $116 million in the quarter were slightly higher than last year, due to higher debt levels and as I think most of you know we did in the latter part of the second quarter issue $500 million worth of U.S.

notes and $1 billion of Euro notes in connection with some of the other funding needs we have for the rest of the year.

Excluding special items, our effective tax rate of 15% continues to compare favorably to our prior year rate of 17% and we did see a drop in income from – attributable to non-controlling interest, down about $11 million compared to last year and that really just relates to the timing of the Hitachi entities as well as some underlying tax rates in those entities.

So overall, we had a solid second quarter, which was at the high end of our guidance at $0.50 which was up 11% versus the $0.45 a year ago.

Turning to slide 14, just a quick Q2 EPS waterfall relative to last year, you can see we had a $0.06 benefit related to cost synergies and productivity savings in the quarter, which was slightly better than the $0.05 expectation we had on our call at the end of the first quarter, also we saw the benefit of reduced intangible asset amortization associated with the sale of the Scott Safety business and treating that now as an asset held for sale.

And there was a $0.01 benefit related to our tax rate. Offsetting these items, were incremental product and channel investments in our businesses of $0.02 and a $0.01 impact of foreign currency.

Turning to slide 15, on free cash flow as we did at the end of the first quarter, because of the significance of the one-off items that we have and the choppiness in free cash flow during fiscal 2017, we wanted to provide a reconciliation for you of the reported cash flow to adjusted cash flow and you can see this quarter, we had about $100 million of tax payments and $100 million of our ongoing integration and transaction costs.

Our second quarter adjusted free cash flow was a solid $300 million and we continue to target adjusted free cash flow conversion of around 80% for the year. Moving to our balance sheet on slide 16, we saw a net debt to capital ratio pretty consistent at around 40%.

And as I mentioned earlier during the quarter we did issue about $1.6 billion of fixed rate long-term debt, $500 million in the U.S. at a rate of 4.5%, and €1 billion at 1%. These proceeds were used to repay outstanding debt, which is primarily commercial paper, and the proceeds will also be used for general corporate purposes.

The financing costs in the second half of the year will be higher than our first half, given the increased debt levels as well as the generally higher interest rate environment as we move into the second half.

In the second quarter, as Alex mentioned, we also increased the original share repurchase program that we had of $200 million to $250 million by $500 million bringing the total for fiscal 2017 up to around $750 million. Turning to slide 17, just touching on a couple of things here, noteworthy, as it relates to divestitures.

We've talked already about the Scott Safety sale to 3M and I've got a specific slide that I'll go through some of the specifics on that and additionally we completed the sale of ADT South Africa for about $130 million.

Second in line with our expectations, we'll continue to have certain special items in the second half of the year along the lines of those listed on the slide.

And then the final thing, I wanted to point out is, we talked about on the first quarter call, the reorganization that was taking place at our buildings business, which will result in a new segment reporting structure for the company and given some of the complexities associated with the IT requirements to get really the underlying plumbing, if you will, in place to report in our new segments.

We will now be doing that in the fourth quarter and at the same time we announce our year-end earnings, we will provide the quarterly results on the new reportable segment basis for fiscal 2017. So you've got that information for comparability as you move into fiscal 2018.

So let's talk a little bit on slide 18 about the Scott Safety divestiture; $2 billion purchase price, I think as you know is based on a 13 times trailing EBITDA multiple and we still believe the net proceeds will be in the $1.8 billion to $1.9 billion range.

If you take that plus the $130 million of proceeds from the ADT South Africa sale plus the cash flow that we expect from the Tyco business in fiscal 2017, we will have paid down the $4 billion of TSarl-related debt at probably the $2.4 billion to $2.5 billion level. So, we're going to end up after we get the proceeds from the Scott sale.

So, by the end of calendar 2017 say, we are going to probably be down to $1.5 billion to $1.7 billion in TSarl debt outstanding. So, real positive development there.

As it relates to the loss of the Scott EBIT, which is $0.07 dilutive that is going to be more than offset by the interest savings and the pay down of the TSarl debt, as well as the share repurchases that we've talked about. Moving to slide 19, we've got a waterfall again here of EPS guidance for Q3.

And just as a reminder, and we've talked about this before, but we're really now entering the second half of this year, which is our seasonally higher earnings period and I guess think in terms of probably 40% in the first half and 60% in the second half.

Our guidance for Q3 is $0.70 to $0.73, which represents a 15% to 20% improvement year-over-year, and again that excludes some of the special items that we talked about previously.

As far as comparative to fiscal 2016 Q3, you can see in the waterfall that our growth will be driven by $0.07 of cost and productivity savings, volume and mix will deliver $0.03, and the lower tax rate will deliver $0.02 year-on-year.

And then, the headwinds that we have going into Q3 would be the continued investments that we make in our business for us $0.01 and we also have FX that's a bit of a headwind for us estimated at $0.01 as well. So moving to slide 20, full year guidance, a couple highlights before we talk about full year guidance.

We are taking our organic growth for the full year down from 2.5% to 4.5%, which is our original guidance. We're now taking that to approximately 3%. Having said that, we still are going to reconfirm our margins at 80 basis points to 110 basis points.

And then, the other thing I would just comment on is, as we talk through the amortization benefit we're getting for the held for sale accounting for the Scott business that is essentially being offset by an increase in net financing costs for the quarter. So those two kind of neutralize each other.

So with all of that, we've tightened the range for our full year EPS guidance from $2.60 to $2.75 down to $2.60 to $2.68, and that still represents a 13% to 16% increase year-over-year. So with that, Antonella, we can it open up for questions..

Great. Thanks, Brian.

Operator, if you could please open-up the line for questions?.

Thank you. We will now begin the question-and-answer session in today's conference. Our first question comes from Gautam Khanna from Cowen & Company. Your line is now open..

Yes. Thanks. Good morning, guys..

Good morning..

Good morning..

Good morning..

So, just on the second half walk at Buildings, clearly we need fairly substantial margin improvement, certainly north of a 100 basis points at Lux. Can you talk about some of the drivers, I mean, obviously there is volume leverage, you have lower investment sequentially in Q3.

But, maybe comment on the profile of the backlog you've been booking, is that actually accretive to the mix or to the margins that you're currently showing? And maybe talk a little bit about some of these projects that you've been booking and whether those are coming in at above segment average margin or any color you can give on why we should have confidence in the second half margin ramp at Buildings? Thanks..

So, I'm going to turn this over to George cause he's into the details, but I just give you a sense for the back half of the year, particularly with legacy Johnson Controls.

What I would tell you is that, the leverage on the volume is going to be the biggest single thing, but you also have to remember particularly in legacy Johnson Controls, the HVAC business itself is the service business is high margin and the volumes there are much different than they are in the winter season.

So, you're going to get two things that are going to be incremental. George could talk about the backlog, I don't think there is anything significantly different about the backlog but there is going to be a lot more volume running through there..

Yeah, Gautam. I think to understand the third and fourth quarter, I think we need to drill into the second quarter and then I'll walk you to what you can expect here in the third and fourth quarter. So in the second quarter, the guidance we provided was for a modest increase in the margin rate in the second quarter.

And so what happened was, when you look at the margin that came through we're getting tremendous productivity in costs savings as it relates with the synergies, that's coming through, that's 50 basis points.

The investments that we're making both 30 basis points and when you drill into that, I would tell you across the board we're getting great traction with those investments.

Whether it be in the applied space with our chiller investments, whether it be in the DX space with the work that we're doing in resi and in small commercial, in the control space with our launch of Metasys 8.1 and there's the Verasys platform.

And then across the Fire and Security businesses with the new investments we're making where in spite of the pressure that we've had with the heavy industrial, high-hazard we continue to make great progress there.

The second piece is that we had a project, a very large project that we took a significant charge here in the second quarter that has impacted our margin rate by about 20 basis points. And then the last, I think, is most important as we project third and fourth quarter, is the unfavorable mix, which is about 30 basis points.

And when you think of that mix, our growth, the 3% growth that we achieved in the second quarter was driven by install. And as you know the install revenues come through at a lower margin. And that, at the same time, when our product business was down about 1%.

So as you project going forward and that was roughly 30 basis points which drove the 30 basis point decline in total. So as you project the third quarter and fourth quarter, we have inflection in our products, we see continued momentum in the legacy BE product businesses.

We start to see, we – sequentially we are seeing growth in the Fire and Security product businesses and they'll continue to accelerate in the third quarter and fourth quarter and so that is good mix coming through.

And then as the Alex talked about, seasonally we start to get our pickup in service revenues in the third quarter and fourth quarter which is good mix. And then with the, just the nature of the business being higher volume in the third quarter and fourth quarter, we get nice leverage on that volume.

And so as we look at now third quarter and fourth quarter, we're positioned to deliver about a 90-basis point improvement in margin rate. And that ultimately supports the overall margin rate that we projected for the company for the year..

Understand one more thing that, that....

And that 90 basis points that...sorry, go ahead..

So I was just going to add one more thing that the Hitachi sales were down for the quarter. We have line of sight to some orders that are seasonal that last year, we saw in one quarter and now we're going to see in the third quarter. So I also think that we have some pretty good confidence around the Hitachi business also..

Your next question comes from Nigel Coe from Morgan Stanley. Your line is now open..

Thanks. Good morning, guys..

Good morning..

Good morning..

Good morning..

So I just want to kind of pick up where Gautam left off. So, as we go into second half year, I think you've threaded the bridge quite nicely, the down 30 basis points. So it looks like synergies will be picking up to maybe 60 basis points, 70 basis points, maybe 80 basis points in 3Q and 4Q. Hopefully, no more charges. So that goes away.

Is there enough growth in products to get us to a positive mix in the second half of the year? And then on Alex's comments about Hitachi picking up in 3Q, my understanding is that Hitachi is a lower margin business.

So why does that help margin?.

Yeah, Nigel, let me start with Hitachi. So starting there we do see from a second quarter to third quarter last year, we had a timing of shipments that ultimately now this year has pushed to the third quarter. That's going to give us a nice lift within the legacy BE product portfolio.

When you look at products in total, just pure volumes, and that starts with the – the demand that we see in the – in the order rates that we're seeing across our – across all of our product businesses accelerate in the third quarter and fourth quarter.

And as I've been – we've been talking about in the legacy Tyco product businesses, we've seen sequential improvement continuing every quarter. And although, we have been – we went from mid – down mid-single digits in the first quarter, down low single digits in the second quarter, we're going to inflect here in the third quarter and fourth quarter.

We're seeing continued acceleration with the end markets recovering that we support. So, that gives us a lot of confidence with that mix coming through, as well as service. When you look at the – the service business across both sets of businesses coming together. Think about it this way.

We've got a tremendous field organization, that now has come together, that have a combination of customers that they are serving and now we can take our combined capabilities to be able to do a lot more for the customers that we serve. And we're already seeing some of that traction come through.

And so, we are very confident that we're going to see an uplift there with that mix in the third quarter and fourth quarter, typically, it's a seasonal high for us. But above and beyond that, we believe that with some of the revenue synergies that we see, we're going to be able to capitalize that in the second half.

And that again would be very positive mix to the overall portfolio..

Great. Thanks. Thanks, George. And a quick follow on, on the product side, down one (39:00) you saw in 2Q.

How did that look ex-Scott Safety? Was it – was Scott accretive to that number? And then, is there anything non-cyclical going on in terms of retail or in terms of residential where there might be some market share loss, so some (39:16) structural pressures in those markets?.

No, Nigel. As we look at all of our product businesses, we've been performing and continuing to maintain and grow share across all of the segments. So there is no concern there as far as losing share.

When you look at the type of product businesses, there was similar type pressure within the Scott Safety as it relates to the heavy industrial, high-hazard business. Recall that we had bought the IST Business, which gave us a bigger portfolio, bigger footprint into that end market, that has been somewhat pressured here short-term.

But again, we're beginning to see a very nice pipeline of orders or activity in orders coming through, and that will also inflect here in the second half of the year..

And Nigel, the only other thing I would point out is, remember our – the legacy Tyco retail business actually sits in the field, and that is continuing to perform well..

And Nigel, this is Alex. I thought I would use it – since you ask about share, we talked about growth in products because one of the things that's, may not be clear, as we looked at how we put out our numbers, and as we pull together the organization – and I mentioned it, but I just wanted to put a little finer point on it.

Our Light Commercial and Residential businesses are performing extremely well and outperforming the market, and as I look at what's happening with our peers, and we're just – I'm really proud of what the team is doing, and we're seeing the same thing in our Applied business.

So, our HVAC businesses are really doing well, and then I think then as the volumes increase seasonally, that's going to drop to the bottom-line. So I just wanted to make sure that didn't get lost because of how we're reporting the numbers here..

Speakers, our next question comes from Jeffrey Sprague from Vertical Research. Your line is now open..

Thank you. Good morning or good afternoon. Hey, just a couple of things, lot of talk about comparisons as we work through all the moving pieces. I get the seasonal lift H1 to H2, it does seem that the comparisons of legacy Tyco especially but even JCI BE organically are a bit harder as we move into the back as particularly the June quarter.

This is as you look at kind of the backlog conversion, just kind of wondering your confidence level really in that 3% organic growth number, for the June quarter and maybe you can give us some color on how that splits between BE and Power?.

As far as the growth or the....

The organic growth..

Organic growth..

So, Jeff, just to go through each of the segments, so when you look at Buildings and what we're seeing not only in the – we're building a very strong pipeline. We're beginning to convert at a higher rate that pipeline and that's positioned us to continue to accelerate the revenue that we achieve.

Now remember there was a large shipment last year in Hitachi that moved from second quarter to this year's third quarter, that's going to be a significant contributor to the pickup in organic growth this year.

And then with what we see coming through based on what's been booked, we see continuing at or above the rate that we're currently at in the third quarter and being able to continue to accelerate in the fourth quarter on that conversion that gets us to roughly, it's roughly 2.5% for the – roughly, kind of mid – 2.5% to 3% for the year within the segment.

So, we're feeling very good about our ability to be able to execute on that. In the Power business it really depends on how the lead fluctuates and how it's reported. But at the end of the day, we're right now seeing a roughly mid-single-digits in the third quarter.

We typically have our seasonal high in the fourth quarter and based on what we see today, that's going to be very strong in the fourth quarter. So as we look at the total year, we're still in the 4% to 6% range for the organic growth in Power.

So overall we feel very good about the activity that we see, how we're converting the market activity and ultimately the position that we're in to be able to deliver on the second half..

Yeah. Just on Power, for a lot of you, it might be your first cycle through Power.

So, you may not have lived through this, but a lot of the seasonality is something that happens, it's not something to worry about, what you worry about is if we lost any share, and we haven't lost any share, in fact we've gained share and then when you think about the growth in the emerging products around AGM that's really going to bode well for the future.

So I think our confidence level is high. We can't control sometimes the quarter to quarter seasonality, but I think the team there, when we talk to them, they feel pretty good about the rest of the year. As it relates to Buildings, I mean I think George hit it right.

I feel good about the progress we're making and I think that the fact that we're starting to see the orders come through certainly within the field and then just going to come through in the products, I think we'll start seeing the leverage. And I think that shows up and it's tightening the range..

I would just add this, Jeff, to summarize what George said, I mean, when we look at Q3, we've really got Buildings around 3% as it relates to organic sales growth and I think Power Solutions is probably in the 4.5% to 5% range and when you put those together, we're in that approximate 3% organic growth for Q3 and based upon what our teams have told us and us looking at opportunities, we think that's very doable at that 3% level for Q3, so..

Great, thanks for all that color.

Then separately, on just TSarl obviously you have stepped up now and done some share repurchase, but given that you've knocked that down so hard, is your urgency on further reduction somewhat diminished, and can we see maybe a stronger pivot to share repurchase in say 2018 whereas at least I was thinking maybe it was a 2019 story on share repurchase?.

Yeah. That's still something we're going to have to look at, Jeff. I mean, technically, the answer is until that entire $4 billion is paid off, you have to have pretty robust procedures and controls in place to ring-fence that debt.

There may be a practical level at which time you look at it and say if it's down at a certain level, you don't necessarily need to be as strict with the rules. But I would tell you that if we get that down to $1.5 billion to $1.7 billion at the end of next year, we've always kind of looked at 2018 as being further pay down.

And once that gets down to less than $1 billion, I think we probably have a little bit more flexibility relative to share repurchase. But I would just tell you that's something we haven't fully analyzed yet. But the good news is, the pay down of the debt is coming at a much faster rate than we had anticipated quite honestly six months ago..

Speakers, our next question comes from Deane Dray from RBC. Your line is now open..

Thank you. Good morning, everyone..

Good morning..

Good morning, Deane..

Hey, I would like to get a little more color on this Texas University integrated win because this is really part of that whole holy grail of integrated building services that you're working towards.

So the idea of like, were these separate bids or bundled bids? How many points of contact did you have during this process from the customer side and what do you do with regarding any product subsidies, one business subsidizing the other in this process and how do you referee those?.

Yeah. So, we're going through a major integration of our field force in North America, and certainly, we're going to be positioned as a leader across all of our domains. And what's been nice is, while we're going through that process, the teams are working within their current structures in how they're continuing to serve customers.

And while we're integrating all of our systems and processes, have found ways to be able to leverage the customer base that we serve today. And then, as new opportunities are coming up, we're getting kind of first look on those opportunities with the other domains that we are not serving those customers with. And that is simple as that.

That's what this was. We have a strong relationship in one of the businesses, working with this customer, and then have gone forward to say, this would – this is what our total capabilities are and what we can ultimately do. It came through one bid opportunity that we put all of our capabilities together.

And because of that, we can maintain our fundamentals, while we're getting the additional growth by putting all of our capabilities together. So, we're seeing this, a lot of this activity, across our entire field, and that's what's building a pretty robust pipeline of opportunities that we're beginning to covert..

Hey, Deane. What I would say is that this is going better than we thought. And, just to put it in simple terms, you talked about one project because we highlighted it. But there are, we're tracking these things, all the way here because it's an important part of why we did this, and things are happening quicker than we thought.

And then George is a little bit modest because we've adopted an organizational change particularly in North America where we're bringing people together. And so, a lot of the – kind of the underlying question about, how hard is this to work together, a lot of those barriers are already broken down. So, I am really bullish on this.

And in fact, it was a big strategic question a year ago, would we get the pull through and the cross selling that we expected and I tell you it's going to be better than we thought..

Got it. And then just as a follow-up on the Scott Safety divestiture.

Just give us a sense are there more non-core divestitures that you're looking at? I mean, when I look back at the South Africa decision that makes complete sense you did this several years ago with exiting South Korea, those are special situations you really can't leverage the brand, it's a different set of security laws.

But within the portfolio are there more divestitures that you're looking at?.

Well, Deane, we certainly are going to tell you everything that we're doing. But I would just say that we're looking across our portfolio as our strategy gets tighter and tighter around being a leader in Buildings and Energy, it helps us understand, what are some of the opportunities there.

Because what we want to make sure is we invest in the businesses that makes sense for us. When you think about the Scott Safety business, what a great business that is. It's a fantastic business. But you know, it's probably not at the right place when you think about where we want to invest going forward.

So I guess, the short answer is we're continuing to look, I think that what we've done so far is right on point. And I know that legacy Tyco folks will open up their portfolio, certainly at Johnson Controls we're doing the same thing.

Now, we have a different framework, because we're a combined company and we certainly are taking a relook at some things that maybe, we haven't thought about in a while. So just kind of leave it with that unless you have something to add, George..

Our next question comes from Julian Mitchell from Credit Suisse. Your line is now open..

Hi, good morning..

Good morning..

Good morning. So, you gave some good detail on the improving mix from here in Buildings. So I guess if we look at Power Solutions, you had double-digit underlying profit growth again year-on-year, same rate as in Q1. So obviously mix is a good tailwind there in the first half.

Maybe clarify, how confident you are that those mix tailwinds can persist in the second half? And I just wondered related to that, if there is any kind of guidance now for the year on the ex-lead margin in that business?.

Yeah. So Julian, what I would say in Power Solutions, we've done a really nice job driving productivity, continued productivity, as well as we're benefiting from the mix, the higher mix of the AGM.

And so that has enabled us to offset the 220 basis points of headwind that we had on lead and being able to offset that for the quarter and deliver a margin rates that were up 10 basis points.

As you project the year, we're going to see continued mix there with continuing increase in AGM shipments and that'll continue with all of the capacity we put into place and over the next few years that will continue. And we're still getting very strong productivity.

So overall, for the year, when we project the margins, I think it's – we're going to be modestly down for the year. But overall, that's really a factor of the lead pricing.

Brian, I don't know, if you want to comment?.

Yeah. Julian, I think, it really is a function, with the lead prices where they are now, there will be pressure on reported margins. But if you look at our margins ex-lead, we should see positive improvement year-over-year there.

So with the volatility in lead, you really need to look at those margins, as you know, ex-lead and those should be up year-over-year..

So Julian, the last thing I'd just add to this, if you look at it on a long-term basis, there's two things that are going to end up happening, underlying.

First is, our AGM mix will continue to add as a positive to our margins and then we're going to continue to launch capacity particularly in China and as we go through the launch of some of these China plants, it will be a little bit lumpy as that happens.

So those are the two things, I mean there's obviously lots of other things as it relates to timing, but if you think about our business moving forward, overall margins will improve, but as we add capacity there will be some lumps in this as we go..

Thanks. And then just my second question would be, maybe more for Brian. You gave a little bit of color on the sort of aggregate part of the gross debt, at the end of this year, the calendar year.

Maybe, when we think about other factors like cash restructuring charges and the moving parts around cash taxes, is there any update you could provide on the net debt or net leverage level you expect 12 months from now at the company?.

Well, I think the leverage that we've talked about historically has been 2% to 2.5% and I think with the choppy cash flow we've had in 2017, you really need to look to 2018 to see what type of balance sheet flexibility we're going to have.

But, I think once we get out of this year, as I mentioned, we still target 80% free cash flow conversion, but that's on an adjusted basis, right. So we're going to need to get into fiscal 2018, kind of get our feet underneath us a little bit relative to a year that's a bit more normal.

And, I think with the cash flow in fiscal 2018, we're going to be in a position where we can further pay down debt and improve our leverage position. Now, the one thing, I'd point out as we look at fiscal 2018 and 2019, the term debt payments that we have coming due are pretty nominal.

It's really into 2020 before we start seeing any term debt repayments of any significance. So, we've got a lot of flexibility as we look at 2018 and 2019 and our cash flow gets to a more normalized position..

Operator, we have time for one more question..

Next question comes for Steve Tusa from JPMorgan Chase. Your line is now open..

Hey, guys. Thanks for slipping me in here..

Good morning..

Good morning..

You guys called out $0.01 of amortization in the second quarter bridge, where is that in the third quarter bridge? Because, I still think you got a, it's probably a benefit year-over-year – bit of a benefit year-over-year still?.

Yep. It fully offsets with the net financing charges in the third quarter that's why you don't see it on the bridge..

Okay. So, it's not a discrete item like it was called out in this quarter. And then just building efficiency. So, you guys talked about I think 50 basis points of productivity but for the year or for the total Co. you had, the productivity was higher than that.

Was there – what kind of – can you just like maybe explain precisely a little bit more around what kind of offset that or is there just a little bit more around, I guess the mix headwinds you had in the quarter? More specifically what types of – what part of the business that was in?.

So, Steve, you're referring more to in Buildings, the mix headwinds that we were talking about?.

Yeah. I guess, I'm just trying to figure out why productivity didn't read through more in building efficiency. Is it, is there greater productivity somewhere else maybe at corporate or in the battery business maybe? I would have thought the productivity would have been higher there..

Yep.

So, when you look at the productivity and you look and you see where that sixth sense of synergies and productivity is, you have a piece going through Buildings that George had referenced early of about $30 million and then the rest of it remember you have some through Power because they're having productivity as well because it's synergies and productivity and you also have a piece of that going through corporate.

So it's going across all three of those..

Okay. Got it. So, it's a little more than just kind of the pure acquisition synergies, so some of the base stuff that they were doing at Battery prior. And then just one – one last one..

Just for everyone's knowledge, if you remember, we are now talking about productivity and merger synergies as one bucket. It kind of goes all....

Right..

...the way back to the EPG conference. That's – that's really our – if you want to go with the framework we're using, it goes back to EPG a year ago, and it's the framework we've put in place..

That makes a ton of sense. And then, just lastly, this $10 million hit on the contractor project this quarter. What precisely type of project was that? Was that in old JCI, old Tyco? I would assume it was an install job..

Yeah. So it's in the legacy BE portfolio in North America, very large project that working with the customer we had accelerated the execution of that project and took on some additional charges. And so, with that, we'll continue to work with the customer and it's hard to predict ultimately what we'll recover.

But at the end of the day, it's being positioned to deliver on what we've committed to the customer that we're serving, and took some additional costs in the quarter..

Okay. Great. Thanks a lot, guys. Appreciate it..

Thanks. I'd like to turn the call over to Alex now for some closing comments..

Sure. Thanks, everyone, for joining us. I just would like to recap a couple of things. One is, if you look at the businesses, if we're going to see growth this quarter, it's good to see that the Buildings business getting on track. And I feel like we're going to gain some momentum.

And underlying that, we got some stabilization in our products business, the fire protection products business, and some real strong growth in our HVAC businesses, particularly in our light commercial, residential, and even our applied equipment.

So, we think that'll continue and then the other part around our merger cost synergies we're more and more bullish. We've gotten through the corporate piece of this and now we're moving into the Buildings part of it and it's going well.

In the meantime, the sales synergies, and I referred to that earlier, that's secured, that we're seeing through the cross-sell opportunities is a real opportunity. I mean, this is not something that is an abstract. We see the projects, we see excitement and our customers are really embracing this opportunity.

So, it's going to be a tailwind for us in the long run. And so, we're pretty confident we have the right strategy. We look forward to talking about this over the next few months with everyone, but things are getting clear and clear and the teams are coming together. So, I just want to leave it at that and I'll talk to you soon..

Thanks. Operator that concludes our call..

Thank you. That concludes today's conference. Thank you for your participation. You may now disconnect..